Fed's Williams: Neutral Rate May Not Be Much Different From Pre-Pandemic Era

Fed's Williams: Little Change in Neutral Interest Rates

John Williams, the president of the New York Federal Reserve and considered the Fed's third-in-command, has indicated that the neutral interest rate in the U.S. economy may not be much different from what it was before the COVID-19 pandemic. This statement implies that the structural factors that previously suppressed interest rates are still in place.

In prepared remarks for a conference hosted by the Mexican central bank, Williams stated that "the global trends in demographics and productivity growth that pushed r* down have not reversed." The term "r*" refers to the neutral rate of interest, which is the level that neither stimulates unemployment nor combats inflation.

Based on statistical estimates of the neutral rate in early 2025, Williams noted that it "has not seen a meaningful rebound," adding that "the era of low r* seems far from over.""

Impact of r* Estimates on Monetary Policy

However, Williams cautioned against relying too heavily on precise estimates of metrics like "r*," citing the uncertainty surrounding the economic factors used to estimate its value. This comes as the Fed is considering cutting interest rates amid concerns about the inflationary impact of tariffs.

In a speech last Friday, Fed Chair Jerome Powell opened the door to a possible rate cut in September, against the backdrop of emerging signs of weakness in the labor market. So far this year, Fed officials have kept their benchmark federal funds rate steady, citing concerns that tariffs imposed by the Trump administration would fuel inflation.

With the target range for the federal funds rate currently at 4.25% to 4.5%, differing estimates of the neutral rate could intensify a debate about the size and pace of rate cuts. Projections released in June show that the median estimate among Fed officials for the neutral rate is 3%, up from 2.5% before the pandemic, but the range of estimates spans from 2.5% to nearly 4%.

Market Expectations and Rate Cuts

The market is currently widely anticipating a rate cut in September. According to CME's FedWatch Tool, the probability of the Fed cutting rates by 25 basis points in September exceeds 80%. However, data released before the decision will still influence the trajectory of the "dot plot," particularly regarding whether it will signal a cumulative cut of 75 basis points this year (i.e., two additional cuts after the September cut), or just 50 basis points (only one cut after September).

“We speculate that the mid-2025 median dot will again signal just two rate cuts this year, but against a backdrop of a ‘changing risk landscape,’ there is scope for the median dot to move lower, signaling a cumulative 75bp of easing before year-end,” wrote Wrightson ICAP macro analysts.

Williams did not offer his own estimate of the neutral rate in his prepared remarks, nor did he comment on the outlook for policy or the economy. Last month, he said that given the inflation threat posed by tariffs, “adopting a moderately restrictive stance on monetary policy is entirely appropriate.”